China's Other Potential Banking Crisis
Summary
The tip of a troublesome iceberg has shown itself in a rarely
glimpsed part of China: its vast, rural countryside. Authorities in
Beijing say they will inject the equivalent of billions of dollars
into the network of rural credit cooperatives that serve the
banking needs of China's farmers. The move highlights the desperate
condition of these institutions, which even China's central bank
admits are insolvent as a group. Halfhearted reforms are worsening
the cooperatives' financial problems and can trigger serious social
unrest.
Analysis
A Sept. 17 article in China's English-language Business Weekly
reports the People's Bank of China, China's central bank, will "re-
lend" 33.3 billion yuan, about $4 billion, to the country's rural
credit cooperatives. The cooperatives, in turn, are being urged "to
make full use of the funds to support agricultural production and
increase farmers' income," the paper says.
This seemingly trivial fragment of news provides a rare - and
disturbing - glimpse into the operation of the more than 40,000
rural credit cooperatives, the main banking option for Chinese
farmers and one of the least understood parts of the country's
financial system. The need for a sudden addition of capital points
to major weaknesses in these institutions, which could threaten
economic and social stability.
The troubles of the country's big banks, the so-called "Big Four"
banks, are comparatively well known. These state-owned behemoths -
which together hold more than 60 percent of loans and deposits -
are close to insolvency after years of lending to unprofitable
state-owned industries. However, there's little chance that
depositors will lose confidence in the large banks any time soon,
particularly since China's currency is non-convertible and there
are few alternatives for stashing domestic savings.
The same can't be said for China's smaller financial institutions,
which operate in limited areas and can be easily wiped out by
depositor runs. There already have been several instances of credit
cooperatives failing in major cities, typically because of reckless
lending into the real-estate bubble of the early 1990s. One well-
publicized example took place in September 1997, when a run on a
credit cooperative in Beihai eventually led to the collapse of all
14 cooperatives in the city. The central bank moved in October 1998
to liquidate the failed institutions and begin paying off their
depositors in stages.
The rural economy - and about two-thirds of the population living
in the countryside - relies on another network of institutions, the
country's tens of thousands of rural credit cooperatives. Here,
farmers and small enterprises place their savings and capital.
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These institutions have received little scrutiny, in part because
they are new players in the Chinese financial system. Until a few
years ago, they operated as passive "deposit-taking stations" for
the Agricultural Bank of China, one of the Big Four state banks. As
such, they simply offered passbook savings accounts to farmers and
deposited the resulting funds with the Agricultural Bank. During
the 1990s, however, the rural cooperatives were spun off and
empowered to issue loans on their own.
But it's not clear where the money is going, who has been receiving
the loans or how prudent the cooperatives have been in extending
them; it's worth noting the employees are essentially bank tellers
with no experience in risk management. It's believed the rural
cooperatives are heavily exposed to China's so-called Township and
Village Enterprises (TVEs), quasi-private businesses established by
local governments in rural areas.
The TVEs have been spectacularly successful in generating
employment and GDP growth, forming the core of China's "economic
miracle" in the 1980s and early 1990s. More recently, however, the
sector has been faltering, with job creation stagnant and many
enterprises bogged down in massive debts. That's not encouraging
news for either the TVEs or their creditors.
There are signs, however, of serious trouble. The People's Bank of
China has acknowledged the rural credit cooperatives, as a group,
had negative net worth by 2000. The central bank traditionally
understates problems in all sectors of the financial system; this
is the only area in which the central bank openly admits to
problems.
Rather than shutting down failed credit cooperatives, the central
bank has generally sought to merge them with stronger ones, thereby
spreading insolvency throughout the sector. The central bank has
also been injecting funds directly into the sector: Statistics for
end-March 2000 show that since the first quarter of 1997, the
People's Bank had lent a total of 30 billion yuan, about $3.6
billion, to rural credit cooperatives.
The infusion planned for this month will more than double that
figure - which suggests that the cooperatives' need for outside
support has increased sharply. Those loans might make sense if they
were used to close insolvent cooperatives and pay off their
depositors. Instead, the cooperatives are being encouraged to re-
lend the money to support rural development.
According to Business Weekly, this policy demonstrates "that the
State is enhancing its efforts to increase rural consumption." In
other words, the cooperatives are being used to stimulate the
economy through increased lending - most likely to the troubled
TVEs, whose role in job creation has helped keep the countryside
politically stable.
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The government in Beijing is refusing to shut down these credit
cooperatives and local enterprises clearly because it fears a
social and political backlash. According to some estimates,
farmers' incomes have declined every year since 1996 and they are
likely to fall further once the World Trade Organization opens
China's agricultural market to imports. In the next few years,
China will need the TVEs more than ever to soak up surplus rural
labor, and the authorities may simply have decided to keep them
afloat at any cost.
The risk here is that the credit cooperatives could quickly lose
their deposit base if farmers start to question their stability.
The Big Four banks represent a safer alternative in the minds of
many savers, and the old peasant option of stashing money under the
mattress is also regaining popularity, in part because cuts in
interest rates have reduced the return on a one-year deposit to
just 2.25 percent. Since most Chinese farmers rely on savings to
deal with medical emergencies and other large expenses, such low
rates may not justify the risk of having an account frozen if a
cooperative gets into trouble.
The need for support from the central bank suggests rural customers
are already fleeing the cooperatives - which would force them to
choke off new lending even to healthy TVEs.
The last thing Beijing wants is more unemployment in an already
restive countryside, so the stopgap solution will probably be to
pump further support funds into the cooperatives, while inciting
their managers to lend even more indiscriminately. Many rural
officials and entrepreneurs are likely to see this as a blank check
for looting the institutions through loan fraud.
If so, the People's Bank of China could be left holding massive
claims against a hollowed-out cooperative sector, whose paper
assets would consist largely of fraudulent or unrecoverable loans.
With legitimate rural businesses unable to get credit, the result
could be a sharp rise in unemployment in China's countryside - with
potentially huge political consequences.
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